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Subject ECONOMICS

Paper No and Title 3 – Basic Microeconomics

Module No and Title 1- Introduction of Microeconomics

Module Tag ECO_P3_M1

ECONOMICS PAPER No. : Basic Microeconomics

MODULE No. : 1, Introduction of Microeconomics
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Table of Content
1. Learning outcome
2. Introduction
3. Microeconomics
4. Basic Area of Microeconomics
5. Summary

ECONOMICS PAPER No. : Basic Microeconomics

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1. Learning Outcomes
After studying this module, you shall be able to

· Know how Economics and its two branches, Micro-Economics and Macro-Economics
are
· Learn whether Economics is a Science or an Art, is Positive or Normative
· Identify the broad areas of Economics, such as Consumer Choice, Production Behaviour,
Markets and so on,
· Evaluate the relation in which Economics stands in relation to other subjects.
· Analyze the Economics approach to the world around us-especially the Micro-economic
approach.

2. Introduction

To understand what Micro-economics is, one must know what Economics is.

2.1 Etymological and general meaning of Economics.

Etymologically, the term Economics comes from the Greek words oikos ( house) and nomos (
management).

In the present-day sense, Economics is a subject whose study assists individuals, groups, nations
and even international organizations make important choices for material welfare, both short-term
and long-term, under limitations or constraints of resources. Under its widespread umbrella
comes the individual or the household going to the market, the firm trying to make profits, the
village growing into an industrial town, the less developed country striving for development,
multinational organizations and the world economy in general.

2.2 Evolution

Even though the term Economics had not come into usage, there was thinking on economic issues
in Western Europe in the 16th to late 17th centuries that go by the name Mercantilism or merchant-
like thoughts. It emphasized the role of the government in following policies leading to a positive
Balance of Trade, was thought to be the index of the country’s prosperity.
In the second half of the 18th century, there emerged economic thoughts that go by the name
Physiocracy. It emphasized the role of land and agriculture in ensuring a country’s prosperity.
The Mercantilists had focused on trade and commerce and accumulation of gold and silver. The
Physiocrats focused on productive work, leading to the generation of agricultural surplus.

In the third quarter of the 18th century, with the publication in 1776 of An Inquiry into the Nature
and Causes of the Wealth of Nations Adam Smith, Classical Economics was born. Britain was
beginning to experience the Industrial Revolution. Smith emphasized Division of Labour or
Specialization as the source of productivity or efficiency in factories contributing aggregatively to
the nation’s wealth or prosperity. J.B.Say, T.R. Malthus, David Ricardo and J.S.Mill enhanced

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his ideas made their contributions to this new body of thought.

They came from different professions but all of them had an
aggregative approach, took a long-run perspective and made sweeping generalization. Together
with Adam Smith, they constitute the Classical economists.
Towards the end of the 19th century, there developed a new approach, which has come to be
called Neo-Classical. Economists began to study economic issues on a more individual level,
asking how the price and quantity of specific goods (and services) were determined in the
market, and how firms set their wages, maximizing their profits and minimizing their costs. The
canvas became smaller, the conclusions less sweeping. Instead of the aggregates, the units
became marginal or incremental., Instead of the entire nation, the individual consumer or
producer became the focus of interest.
Decisions depended on a rational weighing of costs and benefits leading to a balance or
equilibrium. It is this equilibrium that became the most important objective rather than the wealth
of nations, that is, growth.
Menger, William Stanley Jevons and Alfred Marshall are foremost among these new thinkers
who came to be called `marginalists’ or Neo-Classicals.

2.3 Marshall’s Definition of Economics

Marshall’s Principles of Economics ( 1890) , the pioneering work of Neo-Classical tradition,

provided the following definition of Economics: "a study of mankind in the ordinary business of
life; it (Economics) examines that part of individual and social action which is most closely
connected with the attainment and with the use of the material requisites of wellbeing. Thus it is
on one side a study of wealth; and on the other, and more important side, a part of the study of
man."
This definition established the character of the subject as for a long time to come. Economics
studied human beings as they go about their everyday life.
2.4Robbins’s Definition

In 1932, in Lionel Robbins’ Essay on the Nature and Significance of Economic Science, Lionel
Robbins highlighted another aspect of the subject, choice under conditions of scarcity.
"Economics is a science which studies human behavior as a relationship between ends and scarce
means which have alternative uses."
First, resources or means of production ( land, labour, capital goods such as machinery,
technical knowledge) are scarce or limited. Secondly, what is applied to the production of a
certain commodity or service is unavailable for the production of another, alternative one. But
human wants for the consumption or use of goods and services ( food, clothing, housing,
education, entertainment ) are countless and unlimited. So people or organizations must chose
among them. Economics is the study of how people (or organizations) can choose to use the
scarce or limited resources to produce various good and services and distribute them to various
members of society for them to consume.
Contemporary Economics is largely built upon this Robbinsian understanding of Economics.

2.4 Is Economics a Science or an Art ?

If we look at the above two equally famous definitions, we see that while Marshall regards it as a
`study of mankind’, which is what Humanities is, Robbins sees it as a Science.

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Most universities award Bachelor of Arts and Master of Arts

degrees for the study of Economics. In contrast, the London
School of Economics offers BSc and MSc degrees to its students of Economics.
Indeed the scope of Economics is so wide that it is difficult to label it as either science or art. It is
perhaps a mixture of both.
As Nobel Prize winner Paul Samuelson put it, “ Not only is Economics at once art and a science,
economics as a subject can combine the attractive features of both the humanities and the
sciences”(Economics, 7th edn, Chapter 1,p 4).
But even if the epithet `science’ is given to Economics, it remains a Social Science. It is, to use
Marshall’s words, `the study of mankind’, of people as members of a society or nation or
economy, acting and interacting among themselves in the complex process of production and
exchange, consumption and distribution.
There is, of course, the concept of a Robinson Crusoe Economy where the country has just a
single person performing all the economic activities by himself. The name is borrowed from the
title of a book by Daniel Defoe on a man shipwrecked on an island. But this is merely an
analytical tool to facilitate the understanding of the complex reality of an actual economy.
Essentially, the subject Economics is social in character.

2.5 Is Economics Positive or Normative ?

In 1953 Milton Friedman , in his Essays in Positive Economics, said that economists should not
be Normative, that is, pass moral strictures or make `value judgments’.
They should be Positive, that is, make propositions or statements such as: ‘ If the price of a
commodity goes up, its quantity consumed falls, other things remaining the same’ rather than:
‘You stupid consumer! Don’t go on buying more and more of this commodity when the price of it
was going up.’
Even policy prescriptions or recommendations should be expressed in a calm, categorical way,
such as : ‘If there is inflation and the government prints more notes, the inflation is likely to get
aggravated’, instead of:
‘The government should not do a mad thing like printing more notes when there is inflation in the
country.’

2.6 What subjects does Economics relate to ?

Mathematics and Statistics are tools of Economics, used for theoretical as well as empirical study.
Pioneers like Alfred Marshall used verbal exposition as well as graphs to make their points, say,
about the Demand Curve or the various Cost Curves. But in contemporary times it is impossible
to study Economic Theory without knowledge of Mathematical Techniques such as geometry,
algebra, calculus, set theory, matrices. However, Samuelson assures that it is only for “the higher
reaches of economic theory” that mathematics is needed. For a general understanding, it is
enough to be alert and informed. “.. Logical reasoning is the key to success in the mastery of
basic economic principles, and shrewd weighing of empirical evidence is the key to success in
mastery of economic applications.”( Economics, 7th edn, Ch 1. p 5)
.
Economics is both theoretical and empirical. For empirical analysis, the application of Statistics
to Economics has led to the emergence of Econometrics. Most contemporary research in
Economics is with the help of Econometrics.

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Political Science too helps in the study Economics which

originally was called `Political Economy’. Knowledge of
history and geography too are essential for a grasp of Economics. Sociology and History too are
related areas.
Economic History and Economic Geography have developed as subjects in their own right.

Other subjects or courses that have emerged from Economics are: Commerce, Business
Economics, Business Administration, Business Management. Undergraduate courses in
Commerce and Business Economics compulsorily include courses/papers in Economics.

3. Micro-economics

3.1 The Term Micro-economics

In Greek, the words `micro’ and `macro’ mean small and huge, respectively. Micro-Economics is
the branch of Economics that studies economic issues in small, individual details , as if under a
microscope. In contrast, Macro-Economics studies economic issues in aggregative and overall
forms, looking at the broad picture.
Classical economists like Adam Smith, J.B.Say, and David Ricardo had been concerned with the
nation or the country as a whole, and drew their conclusions on an aggregative basis. Their
analysis was more macro than micro in nature.
Neo-Classical economists like Alfred Marshall, Menger, W. S. Jevons were concerned with
households and firms as individual rather than aggregative entities and used `marginal’ (small
additional or incremental) units in their methodology. .The `margin’ was the concept they used in
their technique of study. The old-fashioned Neo-Classical theory of Marginal Utility, for
example, says that the price of a commodity is decided by the additional `utility’ that an small
additional unit of it yields. Micro-economics is Economics using the perspective of small, micro
units.

3.2 The term Macro-economics

So far as modern Macro-economics( as distinct from Classical Economics which was macro in
character) , It started with John Maynard Keynes, after the Great Depression of the 1930s.
During this Depression, both Europe and America suffered along with their colonies in various
parts of the world. There was accumulation of unsold stock, closure of production units and
widespread unemployment, Both employers and employees were affected. Keynes analyzed the
phenomenon in terms of Aggregate Demand falling short of Aggregate Supply and argued that
under such circumstances if the Government of a country played an active role and stepped up its
own expenditure, Aggregate Demand would be boosted and Depression corrected.
This was the beginning of modern Macro-Economics. Later John Hicks, Milton Friedman, Lucas
and others have developed Macro-Economics to a very-well developed body of thoughts with
many policy implications.

3.3 Micro vs. Macro

Is there any issue of Micro-economics versus Macro-economics? Is either of the two more
fundamental or important? Most universities make the students first take a course in Micro-
Economics and then go on to Macro-Economics. However some universities are now offering
both courses in the same semester or academic year.
ECONOMICS PAPER No. : Basic Microeconomics
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So far as undergraduate and even post-graduate studies are

concerned, it is essential for students to first grasp the concepts
of Micro-economics and then go over to those of Macro-economics. For example, the concept of
the `margin’ is first learnt through Marginal Utility, Marginal Rate of Substitution, Marginal
Productivity etc. and only subsequently used through Marginal Propensities to Consume and
Save. The concept of Consumer Equilibrium has to be learnt prior to its application in the box
diagrams used , say, in the Heckscher-Ohlin Theorem of International Trade Theory.
So far as public policy making (governmental or even corporate) is concerned, macro-economics
is more relevant.
However, as Paul Samuelson has emphasized, that there is no essential opposition between
Macro-Economics and Micro-Economics. “Macroeconomics deals with the big picture – with the
macro aggregates of income, employment, and price levels. But do not think that microeconomics
deals with unimportant details. After all, the big picture is made up of its parts.” ( Economics, 7th
edn, p 362). He has also pointed out that both subjects are “vital” to the understanding of the
subject ( Economics, 7th edn, p 362).

4. Basic Areas of Micro-economics

Micro-economics falls into several broad areas.

4.1 Consumer Choice and Demand

This deals with how an individual consumer( person or household) chooses what
quantities he/she should buy at certain market prices so as to maximize satisfaction, i.e.,
how a Demand Curve or function is arrived at, for the individual and for the Market.

4.2 Production – Cost, Revenue, Profit

This relates to how a productive unit, say, the firm, chooses, on the basis of cost
considerations and revenue prospects, what quantity to produce and sell so as to
maximize profits, i.e., how a Supply Curve or function is arrived at both individual and
Market levels.

4.3 Market - Structure and Strategy

Markets can be of various forms or structures , beginning ,Monopsony). In addition to

standard tools of Geometry and Calculus, Game Theory is often used to analyze the
various strategies suitable for the various markets. So after the analysis of Consumption
and Production, comes the analysis of Markets.

4.4 Factor Payments, Risk, Uncertainty

This relates to the determination of payments for the various factors of production, such
as rent, wages and profits, in terms of marginal productivity, reward for risk-taking etc.

4.5 Welfare Economics

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This relates to the maximization of satisfaction or welfare

for the society rather then the individual. It encompasses
situations of Market Failure, caused often by Externalities, as well as problems caused by
information that is Asymmetric.

4.6 International Trade

Like two or more individuals, countries too can come together in relations of production
and exchange. This inter-national trade too is analyzed in Micro-economic, beginning
with the theories of the Mercantilists and Adam Smith to more modern ones. The
treatment however is different from that of Open Economies in macro-economics, say, by
Mundell-Fleming.

5. Summary

· The subject of Economics helps individuals, groups, nations and international

organizations make important choices for material welfare, both short-term and
long-term, under limitations or constraints of resources
· Economics has evolved right from the 16th century. The early economic thinkers
were Mercantilists, Physiocrats and Classicals. Then came Neo-Classical and
Keynesian economists.
· Alfred Marshall of the Neo-Classical tradition, provided the following definition
of Economics: "a study of mankind in the ordinary business of life.”

· Another Neo-Classical economist named Lionel Robbins defined it as " a science

which studies human behavior as a relationship between ends and scarce means
which have alternative uses."

· Economics is both a science and an art and is positive rather than normative. It is
related to various subjects like History, Geography, Political Science, Sociology
as well as Mathematics.

· Economics can be broadly divided into two branches. Micro-Economics is the

branch that studies economic issues in small, individual details , as if under a
microscope. Macro-Economics, on the other hand, studies economic issues in
aggregative and overall forms, looking at the broad picture.

· Both branches are equally important.

· Micro-Economics includes areas such as Consumer Choice, Production, Market,

Factor Payment, Risk, Uncertainty, Welfare and International Trade.

ECONOMICS PAPER No. : Basic Microeconomics

MODULE No. : 1, Introduction of Microeconomics